What will stocks do in 2014?

Sunday

Jan 5, 2014 at 6:00 AM

On Dec. 31, I watched "The Wolf of Wall Street." Near the beginning of the movie, Rothschild executive Mark Hanna is sitting with Jordan Belfort, who later founds penny-stock brokerage Stratton Oakmont, at a penthouse restaurant table overlooking Wall Street.

Mr. Hanna: "Nobody knows if a stock is going to go up, down, sideways or in circles. You know what a fugazi is?"

I could not have said it better, but I have written many columns in which I suggested that the reporting on stock price movements is, at best, misleading. For example, on Dec. 18, I pointed out that while reporting generally tries to link the state of the economy with prospects for the stock market, the connection does not exist.

For example, since March 2009 the S&P 500 has risen an average of 22.5 percent a year while the economy has grown at a 2 percent annual rate producing about 80,000 jobs a month. By contrast, under Bill Clinton, the S&P 500 rose about 17 percent while the economy was much stronger, growing at a 4 percent annual average and generating 230,000 jobs a month.

The thrust of Mr. Hanna's argument is that stocks are bought and sold on fugazi. And the more people believe in fugazi, the easier it is to get them to buy and sell stocks. This, of course, means more commissions for stock brokers. And Mr. Belfort decides to start a penny-stock brokerage because the commissions on each trade are much higher for stocks that trade for pennies a share on the so-called pink sheets than they are for blue chip stocks.

The final scene of "The Wolf of Wall Street" — in which an audience of aspiring salespeople is mesmerized by Mr. Belfort — suggests the idea of fugazi depends on a great salesperson and people who are eager to believe in the power of fairy dust.

A big part of that fairy dust is the idea that some people actually know what stock prices will do and will go on CNBC and talk to reporters, giving hints of that money-making knowledge to the general public for no charge. Have you ever wondered why so-called stock market experts would be willing to share their stock investment strategies with the rest of the world for free? Are these wealthy stock market players more charitable than the rest of humanity?

Odds are good that they are more greedy than anyone else on the planet and that their words are designed to make people buy the very stocks in which they already have an investment. And if not that, they are making claims that encourage people to trade, which generates higher commissions.

And if you had taken Wall Street's advice in 2013, you might not have invested in stocks at all. After all, Bloomberg's tally of bank strategists' predictions last January for the S&P 500 in 2013 yielded an average of 7.3 percent. That does not sound like a very exciting number, but it is much better than the 0.4 percent return that investors earn in the average money market fund.

The actual increase in the S&P 500 in 2013 was 32.4 percent if you include dividends. That is the best performance since 1997. You would have done better following my incorrect prediction from February 2013 — in which I called for a Dow of 17,000 by year-end — than Wall Street's 7.3 percent prediction for stocks.

Since that Feb. 4 column, the Dow has risen 19 percent, closing 423 points short of the 17,000 that I predicted. But I was right about four out of five reasons that I gave for a rise in stock prices in 2013. For example, I thought interest rates would remain low, which they still are; there would be no economic apocalypse as had been repeatedly predicted; uncertainty — another widely repeated Republican buzzword — would not be relevant (and with a budget in place and the Affordable Care Act enacted I am not sure whether Republicans will revitalize this talking point); and corporate profits would be high — they hit a record $2.1 trillion in 2013. I was wrong about my prediction of a big boost in corporate investment in IT; companies invested about $2 trillion in 2013, up a mere 4 percent.

Now I am feeling uncomfortable about those reasons because I am not sure they explain why stocks rose. Another factor to think about is the ratio of stock prices to the earnings of the companies that comprise the S&P 500 index. By that measure, stock prices are a bit elevated, sitting at a P/E of 20, which is well above the mean of 15.5, according to Yale professor Robert Shiller.

But a look at a chart displaying the P/E ratio back to 1871 suggests that the current P/E is not likely to mean a stock market collapse in 2014. In the years preceding the most recent crashes — in 2000 and 2008 — P/Es soared to 44 and 67, respectively.

I don't know what stocks will do in 2014, but I do not think they will be up as much as they were in 2013. I am certainly planning to invest my retirement money in an S&P 500 Index fund because I do not think I can beat the market buying and selling individual stocks, and I do not want to enrich any budding Jordan Belforts hoping to profit from fugazi. An index fund will enable me to track the market, pay no trading commissions, and lose only a small amount on expenses.

I think stocks will do better than money market funds in 2014, and I will start to get nervous about stock price valuations once the stock market becomes a topic of national media obsession.

That has been a reliable predictor of impending doom in the past, and I will be inclined to sell stocks once I see signs of that happening.